In the 1980s and 1990s, Blockbuster modernized the movie rental business. It offered far more movies than its smaller rivals, used computers to better manage that inventory, and designed its stores to be bright and family friendly. By 1993, just eight years after its founding, Blockbuster was the global leader in movie rentals, with more than 3,400 stores worldwide.
Then Netflix happened. Blockbuster went bankrupt in 2010.
Economist Luigi Zingales mentions the Blockbuster story in a recent paper as an example of how the economy ought to work. A company has an innovative idea, which for a while provides competitive advantage. Later on, a new innovator comes along and pushes it aside.
But Zingales fears that this isn’t happening as often as it should. Instead, he argues, the U.S. economy may be succumbing to what he calls “the Medici cycle,” named for the powerful family of medieval Florence. Their motto — or at least the motto often attributed to them — was “Money to get power. Power to protect money.” And Zingales fears that a version of this motto aptly describes the true strategy of at least some of corporate America.
Zingales’s paper is the latest in a flurry of research and commentary on the rising concentration of corporate power in the U.S.
The basic facts are these: Most industries in the U.S. have grown more concentrated, meaning the largest firms account for a larger share of revenue. At the same time, corporate profits have reached all-time highs, despite lackluster rates of business investment. And the number of new businesses being founded has declined; the number of new growth startups being founded has risen, yet these firms struggle to scale. The cause of these trends is not clear. Theories include the rise of IT and the network effects it creates, less-rigorous antitrust enforcement, and lobbying and excess regulation.
Many have interpreted these facts as evidence that the private sector is becoming less competitive. Big companies are making lots of money, not investing all that much, and yet somehow managing to fend off newer challengers.
But that story seems at odds with the view from the C-suite. The conventional wisdom there is that business is, if anything, more competitive than it once was — and there’s at least some data to support that view. Firms are failing faster than they used to, for instance, and there is substantial evidence that the gap between winning and losing firms is partly driven by technology adoption. And while the pace of globalization may have slowed, it has not retreated. In this view, companies in seemingly every industry are struggling to fend off digital competitors, and in traded sectors they also face competition from overseas.
These two narratives needn’t be completely at odds. As I concluded in a piece last year on the debate over too much versus too little competition:
There’s a pessimistic synthesis between the competition and concentration stories. Perhaps the gap between firms starts out as the inevitable result of competition. Firms concentrate on what they’re good at, adopt new technology, and deliver products and services more efficiently. Having reached those heights, they then cement their status through lobbying or M&A. “Once those firms get there, it may be that they can actually draw up the drawbridge,” said [John] Van Reenen [of MIT]. Maybe competition creates corporate inequality. But maybe it’s lack of competition that preserves it.
That’s more or less how Zingales describes his Medici cycle, and it’s illuminating in that it allows for competition and concentration as parts of the same story. When I spoke to Zingales, he told me that he thinks different industries in the U.S. are in different phases of this cycle. Finance may be moving from a period without much competition into one of disruption, while technology is moving from a period of intense innovation into one of concentrated market power.
Take Facebook as an example. As Zingales’s University of Chicago colleague Steven Kaplan wrote in a separate paper, Facebook and its fellow tech giants “used market forces to their advantage, are profitable as a result, and certainly now enjoy some market power. But they didn’t attain that position through crony capitalism. They have gotten to where they are because they operate in sectors where there are network effects.”
The Facebook example is illustrative because it suggests how multiple causes might be contributing to corporate concentration. Network effects are baked into Facebook’s business model, and they clearly help the company stay ahead of competitors. But Facebook has used the cash generated by those network effects to fend off competitors by buying them. Imagine the competition in the social media space if Facebook had not been allowed to acquire Instagram or WhatsApp. Facebook would still probably be the largest player, but it would be struggling to stay ahead of WhatsApp in messaging, and competing with both Snapchat and Instagram in social. And Zingales argues that Facebook’s current dominance couldn’t have happened without antitrust actions against Microsoft in the 1990s, which limited the company’s ability to move into other areas of software.
Zingales told me that although better antitrust policy wouldn’t entirely fix the lack of competition on its own, it would go a long way. If regulators prevented industry leaders from buying up competitors, it would limit their market power and allow for more competition. Moreover, recent research suggests that many mergers and acquisitions can be profitable for individual companies without being good for innovation or the overall economy.
Beyond policy, the research from Zingales and others is a reminder of the role companies are supposed to play in society. Profits are supposed to be an incentive to create valuable products and new innovations, not a reward for lobbying regulators or being the first company to scale in a particular industry. As Zingales writes:
Most firms are actively engaged in protecting their source of competitive advantage: through a mixture of innovation, lobbying, or both. As long as most of the effort is along the first dimension, there is little to be worried about. The fear of being overtaken pushes firms to innovate. What is more problematic is when a lot of effort is put into lobbying. In other words, the problem here is not temporary market power. The expectation of some temporary market power based on innovation is the driver of much innovation and progress.
That is the right standard to hold companies to. As long as competitive advantage is temporary, even the largest companies have to focus on serving customers in order to stay on top. But if the Blockbusters of the world are able to cement their status and no longer need to fear the Netflixes, customers, competitors, and society all stand to lose.